The money-go-round

RAIL ALL THE WAY - Financing the high-speed link was a rollercoaster ride for LCR. But the solution reached has lessons for similar projects, says Judith Cruickshank.

There must have been times when the team at London & Continental Railways (LCR) wondered if nance for construction of the highspeed link would ever fall into place. For a start, a £5bn-£6bn construction project had to be nanced, an amount in a league of its own for UK private nance initiatives.

On winning the bid to build the 109km Channel Tunnel Rail Link in February 1996, LCR acquired Union Railways, the company set up by British Rail to carry out preliminary route design, and see the enabling bill through Parliament. Also included in the deal was the UK arm of the Eurostar service and large swathes of browneld development land at Stratford and King's Cross.

The government agreed to grant £3bn towards construction costs and £1bn over 25 years for fast commuter trains running on the high-speed track.

Initially the consortium had planned to nance the project by means of a stock market otation, accompanied by the raising of debt. But on investigation this had to be ruled out because of the over optimistic Eurostar passenger and revenue forecasts of all of the CTRL concession bidders.

A formal approach to government for more funding in January 1998 was met with a refusal. However, as nance director Mark Bayley explains, the government itself faced a dilemma. Putting the project out to tender again would have delayed the start of work by at least two years and would probably have resulted in an increased cost. Nor could the project to build the UK's first high-speed railway - part of the trans-European transport network - be allowed to fail.

So LCR was given breathing space in which to find another solution.

Working with shareholder and banker UBS Warburg, LCR came up with a radical new structure for the project that effectively segregated the risks of Eurostar from the risks of the railway construction project. This solution also produced separate risk-transfer packages for both.

Construction of the high-speed link was split into two packages:

Section one ran from Fawkham Junction in Kent to the Channel Tunnel; section two takes the line into the terminal at St Pancras International. This immediately made the project more attractive to Railtrack, which had initially baulked at participating because of the size of the risk in taking on the entire project in one go.

With this new arrangement Railtrack took control of the LCR subsidiary building Section 1 and agreed to purchase it on completion at a price calculated on outturn cost. In return, Railtrack would receive access charges from Eurostar for a 50-year period, plus payment from government for allowing domestic high-speed services to use the line. There was also an agreement allowing Railtrack to purchase section two on the same basis.

The government grant was rescheduled to take account of the revised construction timetable and the government agreed to guarantee £3.75bn of debt. In February 1999 LCR raised bonds worth £2.65bn to fund section one.

These were well-received by the market, Bayley explains, being government-backed and long-dated - a plus for pension funds and life assurance companies who have a need for long-term assets to match longterm liabilities. The benet for LCR was very low cost debt at a rate of about 4.8% per annum, saving a substantial amount in funding costs each year while Railtrack took risk on the project.

Repayment would take place over 40 years.

Everything seemed to be in place, but during 2000 LCR's finance team saw signs that Railtrack was having financial problems and began to plan a strategy to secure completion of the project. Its suspicions were confirmed when Railtrack put forward a new set of proposals for section two that proved unacceptable both to government and to LCR.

LCR's alternative proposal involved putting together a financing and risk transfer plan with a massive and innovative cost overrun package developed and arranged by Bechtel. Project managers RLE and Bechtel would absorb a major part of the first layers of any cost overruns.

The reaction of the insurance market, says Bayley, was 'these guys are going to suffer a lot of pain before we have to start writing cheques', and so it welcomed it accordingly. The plan covers a substantial part of the first £600M of cost overruns.

Bayley adds that Bechtel was essential to the deal because of its access to the insurance markets and its reputation as an effective project manager. Other factors included the progress of section one and the mechanisms structured into running the construction project. Contractors bid a target price and shared in any upside or downside against the target. They also received payment for work completed every four weeks. This reduced the chance of problems or delays building up over a long period and gave transparency in dealing with costs.

Once the plan was in place, consent was given for the final £1.1bn of government-backed bonds to be issued. These were 50-year bonds, some of the longest ever issued at the time, and they carried an interest rate of just 5.1% - representing a further saving for LCR.

In October 2001, the then transport secretary Stephen Byers put Railtrack into administration. This could have been devastating for LCR, given Railtrack's commitment to purchase section one.

Instead, LCR turned the situation to its own advantage by offering the administrators £375M for Railtrack's interests in section one. The deal was completed a year later and LCR sold the rights to operate the railway to Railtrack's successor, Network Rail, for £80M. LCR was once again the sole owner of the high-speed link.

Bayley feels strongly that the financing of CTRL holds lessons for other rail projects.

Segregating the risks of Eurostar from those of the construction project proved a significant benefit. Building the project in phases meant there was less strain on resources and the project team was able to build up knowledge and know-how in the early months of the job, which helped speed the later stages.

Government guarantees meant that the cost of finance fell from about 15% to something in the order of 5% and this was accompanied by a change from full risk transfer in the private insurance market to a shared risk of which LCR and Bechtel shouldered a considerable - although capped - proportion.

The experience of the CTRL is, says Bayley, 'a must-have for future projects'.

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